By: Stanley Altshuller, co-Founder and Chief Research Officer at Novus

Pensions are faced with an ominous future of growing liabilities and declining long-term returns, a trend that could jeopardize a large number of pension funds. The low interest rate environment and stunted expected returns have increasingly led pensions to look toward alternative asset classes such as hedge funds for more robust absolute returns. In the last decade we have, on average, seen pensions increase allocations to hedge funds. By some estimates pensions now allocate over 5% of their assets to hedge fund managers and the number is growing. But can pensions choose the managers that will outperform the market or the average hedge fund manager? For many funds generating alpha in the space has been a continuing struggle. In our seven years of working with large allocators such as public pension funds, we have observed many reasons for underperformance in active management. The problem is not unique to pensions; endowments, sovereign wealth funds and other private funds often suffer the same hardships.

Perhaps the alpha problem can be examined in three stages of the hedge fund investment process for a pension: